The consequences of willful failure to pay payroll taxes

The penalties for failing to pay over trust fund taxes can be severe and sometimes include prison time.

An employer is required to withhold federal income and payroll taxes
from its employees’ wages and pay them to the IRS. Withheld payroll
taxes are called trust fund taxes because the employer holds the
employees’ money (federal income taxes and the employee portion of
Federal Insurance Contributions Act (FICA) taxes) in trust until a
federal tax deposit of that amount is made (Slodov, 436 U.S.
238 (1978)).

Sec. 6672(a) provides that “any person required to collect,
truthfully account for, and pay over any tax imposed by” the Internal
Revenue Code who willfully fails to do so, will, “in addition to other
penalties provided by law, be liable to a penalty equal to the total
amount of the tax … not collected … and paid over.” The term “any
person” is important because Sec. 6672(a) allows the IRS to pierce the
corporate veil and proceed against any person who is responsible for
the corporation’s failure to pay over trust fund taxes, thereby making
that person personally liable for the employer’s unpaid payroll taxes
(White, 372 F.2d 513 (Ct. Cl. 1967)). Therefore, the penalty
can be imposed on any responsible person, regardless of the form of
business entity.

Both the responsible person and the willful failure tests have to be
met for the trust fund recovery penalty to apply. Once the penalty is
assessed, the person held responsible for the failure has the burden
of disproving both those elements.

RESPONSIBLE PERSON TEST

Both the IRS and the courts broadly define a “responsible person.”
The key element in determining responsible person status is whether a
“person has the statutorily imposed duty to make the tax payments”
(O’Connor, 956 F.2d 48 (4th Cir. 1992)).

Several factors indicate responsibility, including whether the person
(1) has power to compel or prohibit the allocation of funds
(Godfrey, 748 F.2d 1568 (Fed. Cir. 1984)); (2) has the
authority to sign checks; (3) has the authority to make decisions as
to disbursement of funds and payment of creditors; (4) is an officer
or director of the corporation; (5) has control over the company’s
payroll; (6) prepares and signs payroll tax returns; (7) actively
participates in day-to-day management; or (8) hires and fires
employees (Barnett, 988 F.2d 1449 (5th Cir. 1993)). Although
the above list is not exhaustive, the status, duty, and authority of
an employee principally determine whether the person is responsible
under Sec. 6672 for paying over withholding taxes to the United States
(Mazo, 591 F.2d 1151 (5th Cir. 1979)).

However, in IRS Policy Statement 5-14 (Internal Revenue Manual
§1.2.14.1.3), the IRS stated that individuals who are nonowner
employees performing ministerial acts without exercising independent
judgment will not be deemed responsible.

Often, company officers do not want to be bothered with accounting or
tax matters. It is not uncommon for a director or chairman to instruct
an employee to take care of paying payroll taxes. If that employee
fails to pay payroll taxes, the officer should be worried. Delegation
of authority does not relieve a person of responsibility to collect
and pay taxes to the IRS. Courts have consistently held that the
authority that permits control carries with it a nondelegable duty to
ensure that withholding taxes are duly collected and paid over to the
government (Purcell, 1 F.3d 932 (9th Cir. 1993)).

The trust fund recovery penalty can also be assessed against a
corporate officer who fails to pay over withheld taxes at the
direction of a supervisor when sufficient funds are available.
Sometimes an officer who is aware of the delinquent taxes does not pay
out of fear of getting fired for disregarding instructions not to pay.
The threat of being fired by a supervisor for paying the taxes will
not make the person less responsible for paying the amounts owed
(Howard, 711 F.2d 729, 734 (5th Cir. 1983)). Courts have held
that an officer is not entitled to prefer his own interest in
continued employment over that of the government (Brounstein,
979 F.2d 952, 956 (3d Cir. 1992)).

A former president of a corporation can also be considered a
responsible person under Sec. 6672 if he or she continues to retain
authority to sign checks and negotiate with the IRS, holds an office
or owns stock in the corporation, manages the day-to-day operations of
the business, makes decisions as to disbursement of funds and payment
of creditors, and has check-signing authority (Turnbull, 929
F.2d 173 (5th Cir. 1991)). CPAs who handle payroll and bookkeeping for
their clients also need to be aware that some CPAs have been held
personally liable for clients’ unpaid payroll taxes and have had the
100% trust fund penalty assessed against them (Erwin, No.
1:06CV59 (M.D.N.C. 2/5/13)).

WILLFUL FAILURE

For purposes of Sec. 6672, a failure to remit trust fund taxes is
willful if it is a voluntary, conscious, and intentional, as opposed
to an accidental, act. Courts have held that willfulness is present if
a taxpayer knew of the nonpayment or recklessly disregarded whether
the payments were being made. This can be established by showing that
the responsible person failed to assess and remedy the payroll tax
deficiencies immediately upon learning of their existence, directed
the corporation to pay other creditors (thereby preferring other
creditors over the IRS), or neglected his or her duty to use all
current and future unencumbered funds available to the corporation to
pay those back taxes (Erwin, No. 1:06CV59 (M.D.N.C. 2/5/13)).

FAILURE TO PAY: HOW BAD CAN IT GET?

It is important for taxpayers to understand that the IRS is
aggressive in assessing the trust fund penalty. Payroll taxes are the
government’s money, and when the taxes are not paid, the government
believes those who have not paid are taking its money. The government
does not take this lightly and will not relent in its efforts to
collect the amounts it is owed. For a business with numerous
employees, unpaid trust fund taxes add up quickly, and the trust fund
penalty consequently assessed against a responsible person can be
huge. In addition, the penalty is not dischargeable in bankruptcy.

Even worse, failing to pay trust fund taxes can lead to criminal
charges. Under Sec. 7202, a willful failure to pay over or collect tax
is a felony punishable by up to a $10,000 fine or five years in
prison, or both. However, the IRS reserves criminal charges for the
most egregious cases, usually where the responsible person owned the
business and diverted the money for his or her own personal use,
rather than situations where an owner or other responsible person in a
business that was facing hard times used the money to pay other
creditors in a misguided attempt to keep the business afloat. As the
cases discussed below show, in a successful criminal trust fund
prosecution, the responsible person is usually sentenced to prison
time and required to pay restitution.

CRIMINAL PROSECUTIONS

A person who is a responsible person under Sec. 6672 can be
criminally liable under Sec. 7202. Thus, Sec. 7202 can apply to
corporate officers, partnership members, employees, and others
responsible for collecting and paying over of withholding taxes. As
noted above, however, the IRS generally targets business owners who
have used funds for their own benefit that they should have used to
pay employment taxes.

Courts have held that Sec. 7202 creates three obligations the person
must meet. The person must (1) collect, (2) account for, and (3) pay
over the trust fund taxes. If the person does not do all three of
these things, he or she has violated Sec. 7202. Defendants have argued
that the last two elements should be considered one element and that a
person who has collected the tax must both not account for and not pay
over the taxes to be guilty. However, the courts have found that the
plain language of the statute does not support this interpretation.

Under Sec. 7202, willful means a voluntary, intentional violation of
a known legal duty. The IRS does not have to prove that the person had
bad faith or a bad purpose. In addition, the financial circumstances
of the person or the company he or she is acting for are not taken
into account in determining whether the failure to pay the tax was willful.

REAL-LIFE EXAMPLES

The following examples of recent criminal employment tax
investigations show the trouble taxpayers can get into if they fail to
properly withhold and pay over employment taxes.

Maryland Business Owner: 24 Months in PrisonIn
January 2013, Alphonso Tillman was sentenced to 24 months in prison
and three years of supervised release for failing to account for and
pay over employment taxes. Tillman was also ordered to pay restitution
of $2,205,991. According to his plea agreement, Tillman was the
president and sole owner of two companies that provided security
guards to protect commercial and residential properties. Both
companies withheld taxes from their employees’ paychecks, but Tillman
failed to file the required forms or pay the payroll taxes due, with
the exception of payments from IRS collection efforts. The total
amount of taxes lost from Tillman’s failure to pay these taxes was $2,205,991.

Tillman spent hundreds of thousands of dollars from the business bank
accounts to cover his personal expenses between 2005 and 2008. “Using
money withheld from your employees’ compensation for personal gain is
reckless,” said Sheila Olander, acting special agent in charge, IRS
Criminal Investigation, Washington Field Office. “Business owners are
responsible to withhold and pay over income taxes from their
employees’ compensation to the IRS. [This sentence] shows failing to
do so is a serious offense to which Mr. Tillman is being held
accountable” (U.S. Attorney’s Office, District of Maryland, Press
Release, March 26, 2013).

Colorado Business Co-Owner: 28 Months in PrisonIn September, Beth Ann Pettyjohn, of Englewood, Colo., was
sentenced to 28 months in prison and three years of supervised
release, and was ordered to pay $4,669,532 in restitution to the IRS,
as well as a $25,000 fine. According to court documents, Pettyjohn,
the co-owner and vice president of Overhead Door Co. of Denver,
stopped paying over the payroll taxes withheld from employee wages, as
well as the employer’s matching portion of FICA, totaling almost $4.7
million. Pettyjohn managed the accounting department, determined which
bills would be paid, and issued and signed checks. She used the money
to buy a number of houses, including paying $285,000 cash to purchase
a condominium for her son.

“Employers who fail to remit employment taxes are victimizing
legitimate businesses by creating an unfair competitive advantage over
those businesses that lawfully pay their share of employment taxes,”
said Stephen Boyd, special agent in charge, IRS Criminal
Investigation, Denver Field Office. “As this sentence demonstrates,
there are real consequences for committing employment tax fraud” (U.S.
Attorney’s Office, District of Colorado, Press Release, Sept. 12, 2013).

Nebraska Couple: Husband and Wife Both Get Prison TimeMichael and Laurie Russell, of Hickman, Neb., were sentenced to
prison terms (16 months and six months, respectively) for failing to
pay over employment taxes. The Russells were also jointly ordered to
pay the IRS $311,486 in restitution. According to court documents, the
Russells jointly owned and operated a window installation business,
for which they withheld employee income and FICA taxes, but paid none
of it to the IRS. The couple lived a comfortable lifestyle and could
afford to pay the taxes, but apparently chose not to.

“Business owners have a responsibility to withhold income taxes for
employees and remit those taxes to the Internal Revenue Service,” said
Sybil Smith, special agent in charge of IRS Criminal Investigation.
“We are committed to pursuing those who violate the employment tax
laws” (U.S. Attorney’s Office, District of Nebraska, Press Release,
July 30, 2013).

BE ALERT FOR NONCOMPLIANCE

Although there are options to help a client resolve its trust fund
liability, such as an offer in compromise, installment agreement, the
IRS appeals process, or litigation, these options can be drawn out,
complex, and expensive. It is better to ensure your client avoids the
trust fund penalty by filing timely payroll tax returns and paying
over payroll taxes. If you know any of your clients have failed to pay
payroll taxes, advise them to make every effort to pay the taxes. If
your clients face financial difficulties, you should advise them to
pay the government before paying creditors. Help your client work with
the IRS by making sure the client makes prompt payments of current
taxes and makes arrangements to pay back taxes.

Make sure your clients take their duty to collect and pay over trust
fund taxes seriously. It is better to be safe than sorry.

EXECUTIVE SUMMARY

People who are “responsible persons” have a duty to collect
and pay over payroll taxes and may find that they are
liable for the 100% trust fund penalty under Sec. 6672.

Both the courts and the IRS have defined “responsible person”
broadly, but the first question is whether the person has a
statutorily imposed duty to make the tax payments.

Before the 100% trust fund penalty can be imposed,
however, in addition to being a responsible person, that person must
also be found to have willfully failed to pay the tax.

The IRS is aggressive in collecting these taxes. In a
number of cases where taxpayers have behaved egregiously, it has also
pursued criminal prosecutions that landed offenders in jail.

Practitioners should be aware if any of their clients have run
afoul of these rules and move quickly to help clients fix
any problems.

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